SCO Files 10K: "We can not guarantee...our claims...will be heard by a jury"

Friday, January 26 2007 @ 07:48 PM EST

Here's SCO 10K for the fiscal year ended October 31, 2006. In it, SCO admits:

IBM has filed 6 motions for summary judgment that, if granted in whole or in substantial part, could resolve our claims in IBM’s favor or substantially reduce our claims....
We can not guarantee whether our claims against IBM or Novell will be heard by a jury.

What they don't tell us is how many employees they've lost since October of 2006, despite reportedly saying at the most recent conference call that they would. They provide the same figure that they gave at the conference call, 142 full-time employees as of October 31. It's now the end of January. There is this sentence: "For the year ending October 31, 2007, we anticipate that the dollar amount of general and administrative expenses will decrease from the year ended October 31, 2006." So I guess we'll just have to remain in suspense. Presumably the upcoming 10Q will tell us more.

There is also news about the arbitration and the IPO litigation, and SCO claims it has enough money to last another 12 months.

Here's the wording about survival for another year:

We intend to use the cash and cash equivalents and available-for-sale securities as of October 31, 2006 to pursue our SCO Litigation and to run our UNIX business. We believe that based on the combination of our existing cash and cash equivalents and available-for-sale securities as of October 31, 2006, we will have sufficient cash resources to fund our operations for at least the next 12 months.

They do, however, list that as a "forward-looking statement."

For those of you curious about the arbitration in Europe, the 10K reveals this tidbit:

The three-person arbitration panel has been selected for the SuSE arbitration in Switzerland, and that process has commenced. The arbitration has been set for December 2007. The proceedings in early 2007 will determine the scope of the arbitration.

And there is news about the IPO litigation, that an appeals court in December decertified the class, which means the settlement agreement probably won't stand, SCO reveals:

IPO Class Action Matter

We are an issuer defendant in a series of class action lawsuits involving over 300 issuers that have been consolidated under In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS). The consolidated complaint alleges, among other things, certain improprieties regarding the underwriters’ conduct during our initial public offering and the failure to disclose such conduct in the registration statement in violation of the Securities Act of 1933, as amended. Class standing was certified for all of these cases by the district court.

The plaintiffs, the issuers and the insurance companies negotiated and executed an agreement to settle the dispute between the plaintiffs and the issuers. While the settlement agreement was awaiting approval by the district court, the court of appeals overturned the class certification on December 5, 2006. It is unlikely a settlement of a class action can remain effective as the class is de-certified. If the decision by the court of appeals is not reversed, we do not believe the settlement will stand, and it is possible the lawsuit may fragment into individual actions. At this time, we do not know and cannot determine the legal or procedural results of such an action. If the de-certification is reversed, and if thereafter the settlement agreement is approved by the court, and if no cross-claims, counterclaims or third-party claims are later asserted, this action will be dismissed with respect to us and our directors. If the settlement agreement is not approved by the court, the matter will continue unless another settlement agreement is reached.

We have notified our underwriters and insurance companies of the existence of the claims. Management presently believes, after consultation with legal counsel, that the ultimate outcome of this matter will not have a material adverse effect on our results of operations or financial position and will not exceed the $200,000 self-insured retention already paid or accrued by us.

Imagine if SCO has to defend against yet another lawsuit.
SCO also acknowledges that should it lose to IBM, Novell or Red Hat, the company's operations and business would be "materially harmed" ("could be" in the case of Red Hat), and that the litigation will continue to be an expense, "costly", in that it has to pay for experts, consultants and other things, so it might have to top off the escrow account again. In addition, it says that if "the continuing litigation requires more cash than expected, our business and operations would be materially harmed". This is in the risks section, so you have to subtract a bit for the context.

But then there is this paragraph:

Litigation Reserves. We are party to a number of legal matters described in more detail elsewhere in this annual report on Form 10-K. Pursuit and defense of these matters will be costly, and management expects the costs for legal fees and related expenses will be substantial. A material, negative impact on our results of operations or financial position from the Red Hat, Inc., IPO Class Action, or Indian Distributor matters, or the IBM and Novell counterclaims is neither probable nor estimable. Because these matters are not probable or estimable, we have not recorded any reserves or contingencies related to these legal matters. In the event that our assumptions used to evaluate these matters as neither probable nor estimable changes in future periods, we may be required to record a liability for an adverse outcome, which could have a material adverse effect on our results of operations, financial position and liquidity.

There are some exhibits too, at the link and listed in the 10K, including a list of subsidiaries.
And SCO claims in this 10K that not only AIX and Dynix are derivatives, but also HP's HP-UX, Sun's Solaris, and SGI's IRIX are "all derivatives of the original UNIX source code owned by" SCO.

This registration statement is being filed solely for the registration of additional shares of Common Stock of The SCO Group, Inc. (the “Company”) for issuance pursuant to the Caldera Systems, Inc. 2000 Employee Stock Purchase Plan (the “Plan”). Accordingly, pursuant to General Instruction E to Form S-8, the contents of the earlier registration statements relating to the Plan (Registration No. 333-43822, Registration No. 333-124102, and Registration No. 333-131349) are hereby incorporated by reference in this registration statement.

The attached exibit, a letter from Dorsey and Whitney, a law firm, says that it is "relating to the sale by the Company from time to time of up to 212,305 shares of the Company’s common stock, $0.001 par value per share (the “Shares”), which are to be offered and sold under the Caldera Systems, Inc. 2000 Employee Stock Purchase Plan (the “Plan”)."

There is a second S-8, "filed solely for the registration of additional shares of Common Stock of The SCO Group, Inc. (the “Company”) for issuance pursuant to The SCO Group, Inc. 2004 Omnibus Stock Incentive Plan (the “Plan”). " The amount of shares to be registered is 632,819, $0.001 par value per share, proposed maximum offering price $1.06.

During the year ended October 31, 1998, the Company adopted the 1998 Stock Option Plan (the “1998 Plan”) that provided for the granting of nonqualified stock options to purchase shares of common stock. On December 1, 1999, the Company’s board of directors approved the 1999 Omnibus Stock Incentive Plan (the “1999 Plan”), which was intended to serve as the successor equity incentive program to the 1998 Plan. The 1999 Plan allows for the grant of awards in the form of incentive and non-qualified stock options, stock appreciation rights, restricted shares, phantom stock and stock bonuses. Awards may be granted to individuals in the Company’s employ or service.

On May 16, 2003, the Company’s stockholders approved the 2002 Omnibus Stock Incentive Plan (the “2002 Plan”) upon the recommendation of the board of directors. The 2002 Plan permits the award of stock options, stock appreciation rights, restricted stock, phantom stock rights, and stock bonuses. Stock options may have an exercise price equal to, less than, or greater than the fair market value of the common stock on the date of grant, except that the exercise price of incentive stock options must be equal to or greater than the fair market value of the common stock as of the date of grant.

On April 20, 2004, the Company’s stockholders approved the 2004 Omnibus Stock Incentive Plan (the “2004 Plan”) upon the recommendation of the board of directors. The 2004 Plan allows for the award of up to 1,500,000 shares of the Company’s common stock and permits the award of stock options, stock appreciation rights, restricted stock, phantom stock rights, and stock bonuses. The 2004 Plan incorporates an evergreen formula pursuant to which on each November 1, the aggregate number of shares reserved for issuance under the 2004 Plan will increase by a number of shares equal to 3% of the outstanding shares on the day preceding (October 31). The 2004 Plan is administered by the Compensation Committee of the Company’s board of directors. The Compensation Committee has the ability to determine the terms of the option, the exercise price, the number of shares subject to each option, and the exercisability of the options. Stock options may have an exercise price equal to, less than, or greater than the fair market value of the common stock on the date of grant, except that the exercise price of incentive stock options must be equal to or greater than the fair market value of the common stock as of the date of grant. Shares issued pursuant to the 2004 Plan may be authorized and unissued shares, treasury shares or shares acquired by the Company for purposes of the 2004 Plan.

Under the terms of the 1998, 1999, 2002 and 2004 Plans, options generally expire 10 years from the date of grant or within 90 days of termination. Options granted under these plans generally vest at 25% after the completion of 1 year of service and then 1/36 per month for the remaining 3 years and would be fully vested at the end of 4 years.

Here's what else stands out to me:

The original UNIX operating system, which we own, was conceived on the premise that an operating system should be easily adapted to a broad range of hardware platforms and should provide a simple way of developing programs. Over the years, the UNIX operating system has been adapted for almost every OEM’s hardware architecture, and today UNIX has achieved the goal of seamlessly sharing data across heterogeneous environments. We own a broad and deep set of intellectual property rights relating to the UNIX operating system, which we intend to continue to enforce and protect through our SCOsource business....

Other Products. In addition to OpenServer and UnixWare, we offer product maintenance and additional UNIX-related products, such as SCOoffice Server, a UNIX-based e-mail and collaboration system and other UNIX system add-ons....

The success of our UNIX business will, in large measure, depend on the level of commitment and certification we receive from industry partners and developers. In recent years, we have seen hardware and software vendors as well as software developers turn their certification and application development efforts toward Linux and elect not to continue to support or certify to our UNIX operating system products. This trend continued for the year ended October 31, 2006, and we believe that it will continue during the year ending October 31, 2007. If this trend does continue as expected, our competitive position will be adversely impacted and our future revenue from our UNIX business will decline, possibly at an even faster rate than it has declined over the last several years. The decline in our UNIX business may be accelerated if industry partners withdraw their support from us as a result of the litigation between the Company and IBM, Novell and Red Hat (the “SCO Litigation”)....

Our product development process is modeled to standard, commercial software engineering practices and we apply these practices to ensure consistent product quality. As a result, we are able to offer our platform products to OEM customers in several configurations without significant additional effort. We incurred $8,045,000, $8,337,000 and $10,661,000 in research and development expense during the years ended October 31, 2006, 2005 and 2004, respectively....

We acquired our rights relating to the UNIX (including UnixWare) source code and derivative works and other intellectual property rights when we purchased substantially all of the assets and operations of the server and professional services groups of The Santa Cruz Operation, Inc. in May 2001. The Santa Cruz Operation had previously acquired such UNIX source code and other intellectual property rights from Novell in 1995, which technology was initially developed by AT&T Bell Labs. Through this process, we acquired all UNIX source code, source code license agreements with thousands of UNIX vendors, certain UNIX intellectual property, all claims for violation of the above mentioned UNIX licenses and copyrights and other claims, and the control over UNIX derivative works. The UNIX licenses we obtained have led to the development of several UNIX-based operating systems, including but not limited to our own UnixWare and OpenServer products, IBM’s AIX, Sequent’s DYNIX/Ptx, Sun’s Solaris, SGI’s IRIX and Hewlett-Packard’s HP-UX. These operating systems are all derivatives of the original UNIX source code owned by us....

As of October 31, 2006, we had a total of 142 full-time equivalent employees. Of the total employees, 40 were in product development, 48 in sales and marketing, 17 in services, 7 in customer delivery and manufacturing, 3 in SCOsource and 27 in administration (which includes finance, human resources, executive management and information systems). From time to time, we also engage independent contractors to support our professional services, product development, sales and marketing organizations. Our employees are not represented by any labor union and are not subject to a collective bargaining agreement, and we have never experienced a work stoppage. In general, we believe our relations with our employees are good. ...

If our revenue from the sale of our UNIX products and services continues to decline, or if we continue to devote significant cash resources to the SCO Litigation, we will need to further reduce operating expenses to generate positive cash flow. During October 2006, we implemented a reduction in force and decreased our ongoing operating expenses in an effort to decrease our total costs. We may not be able to further reduce operating expenses without damaging our ability to support our existing UNIX business. Additionally, we may not be able to achieve profitability through additional cost-cutting actions.

As of October 31, 2006, we had a total of $7,618,000 in cash and cash equivalents and available-for-sale marketable securities and an additional $5,046,000 of restricted cash to be used to pursue the SCO Litigation. Since October 31, 2004, we have spent a total of $9,954,000 for expert, consulting and other costs and fees as agreed to in the Engagement Agreement with our legal counsel in the SCO Litigation. Our limited cash resources may not be sufficient to fund continuing losses from operations and the expenses of the SCO Litigation. ...

We may not prevail in our lawsuits with IBM, Novell and others, which may adversely affect our ability to continue in business.
We continue to pursue the SCO Litigation and believe in the merits of our cases. With respect to our litigation with IBM, both parties are preparing for summary judgment arguments scheduled for March 2007. IBM has filed 6 motions for summary judgment that, if granted in whole or in substantial part, could resolve our claims in IBM’s favor or substantially reduce our claims. We have filed 3 motions for summary judgment.
On November 29, 2006, the District Court issued a ruling upholding the June 28, 2006 Magistrate Judge’s ruling that removed over 180 (out of 293) of our technology disclosures from the case. Additionally, on December 21, 2006, the Magistrate Judge signed an order which held that certain items of technology included in our expert reports go beyond the disclosures contained in our December 22, 2005 filing. We have filed objections to that order with the District Court. The result of these recent rulings is that we still have over 100 challenged items from the December 22, 2005 disclosure in the case with IBM.
With respect to our litigation with Novell, Novell claims it did not sell The Santa Cruz Operation, Inc. the UNIX copyrights and it claims it has the right to waive our claims against UNIX source licensees, such as IBM, Novell has filed a motion for preliminary injunction and a motion for partial summary judgment; we have also filed a cross-motion for partial summary judgment. The Court heard arguments on these motions on January 23, 2007, and as of the date of filing of this Form 10-K, no ruling had been made. If Novell prevails on its motion, some or all of our cash and cash equivalents could be encumbered.

We can not guarantee whether our claims against IBM or Novell will be heard by a jury. ...

During October 2006, we deposited an additional $5,000,000 into the escrow account. In the event that we exhaust these funds, we must continue to pay for expert, consulting and other expenses through the conclusion of our litigation with IBM. As we continue with discovery and other trial preparations, we may be required to place additional amounts into the escrow account, which could further reduce our liquidity position. As of October 31, 2006, we had a total of $7,618,000 in cash and cash equivalents and available-for-sale marketable securities and an additional $5,046,000 of restricted cash to be used to pursue the SCO Litigation. Since October 31, 2004, we have spent a total of $9,954,000 for expert, consulting and other costs and fees as agreed to in the Engagement Agreement with our legal counsel in the SCO Litigation....

We could lose our listing on the Nasdaq Capital Market if our stock price falls below $1.00 for 30 consecutive business days, and the loss of the listing would make our stock significantly less liquid and would affect its value.

Our common stock is listed on the Nasdaq Capital Market and had a closing price of $1.04 at the close of the market on January 24, 2007. If the price of our common stock falls below $1.00 and for 30 consecutive business days remains below $1.00, we will receive a deficiency notice from NASDAQ advising us that we have been afforded a 180-calendar day compliance period. If our stock fails to maintain a minimum bid price of $1.00 for 10 consecutive business days during a 180-day compliance period on the Nasdaq Capital Market or a 360-day grace period if compliance with certain core listing standards are demonstrated, we could receive a delisting notice from the Nasdaq Capital Market, and, under certain circumstances, even if our stock maintains a minimum bid price of $1.00 for 10 consecutive business days, we may receive a delisting notice from the Nasdaq Capital Market. Upon delisting from the Nasdaq Capital Market, our stock would be traded over-the-counter, more commonly known as OTC. OTC transactions involve risks in addition to those associated with transactions in securities traded on the Nasdaq Capital Market. Many OTC stocks trade less frequently and in smaller volumes than securities traded on the Nasdaq Capital Market. Accordingly, our stock would be less liquid than it would otherwise be, and the value of our stock could decrease....

There are risks associated with the potential exercise of our outstanding options.
As of December 31, 2006, we have issued outstanding options to purchase up to approximately 5,499,000 shares of common stock with an average exercise price of $3.83 per share. The existence of such rights to acquire common stock at fixed prices may prove a hindrance to our efforts to raise future equity and debt funding, and the exercise of such rights will dilute the percentage ownership interest of our stockholders and may dilute the value of their ownership. The possible future sale of shares issuable on the exercise of outstanding options could adversely affect the prevailing market price for our common stock. Further, the holders of the outstanding stock options may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us.
Common stock available for resale may depress the market price of our common stock.

We have filed a post-effective amendment to a registration statement with the Securities and Exchange Commission (“SEC”), which has been declared effective, covering the potential resale by two of our stockholders of up to 923,019 shares of common stock, or 4.3% of our outstanding common stock. The selling stockholders are bound by certain selling limitations, which limit the numbers of shares of our common stock that may be sold at one time. In addition, we have filed a registration statement with the SEC, which has been declared effective, covering the potential resale by some of our stockholders of up to 2,852,449 shares of our common stock, or 13.4% of our outstanding common stock. The existence of a substantial number of shares of common stock subject to immediate resale could depress the market price for our common stock and impair our ability to raise needed capital....

The right of our Board of Directors to authorize additional shares of preferred stock could adversely impact the rights of holders of our common stock.

Our Board of Directors currently has the right, with respect to the 5,000,000 shares of our preferred stock, to authorize the issuance of one or more additional series of our preferred stock with such voting, dividend and other rights as our directors determine. The Board of Directors can designate new series of preferred stock without the approval of the holders of our common stock....

Deferred Income Tax Assets and Related Valuation Allowance. The amount, and ultimate realization, of our deferred income tax assets depends, in part, upon the tax laws in effect, our future earnings, if any, and other future events, the effects of which cannot be determined. We have provided a valuation allowance of $76,385,000 against our entire net deferred income tax assets as of October 31, 2006. The valuation allowance was recorded because of our history of net operating losses and the uncertainties regarding our future operating profitability and taxable income....

Impairment of Property and Equipment. We review our long-lived assets for impairment at each balance sheet date and when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows of the related asset or group of assets is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair market value of the long-lived asset. Economic useful lives of long-lived assets are assessed and adjusted as circumstances dictate.
Write-downs of long-lived assets may be necessary if the future fair value of these assets is less than the carrying value. If the operating trends for our UNIX or SCOsource businesses continue to decline, we may be required to record an impairment charge in a future period related to the carrying value of our long-lived assets....

We initiated our SCOsource business for the purpose of protecting and defending our intellectual property rights in our UNIX source code and derivative works. SCOsource licensing revenue was $116,000 for the year ended October 31, 2006, $166,000 for the year ended October 31, 2005 and $829,000 for the year ended October 31, 2004. The SCOsource revenue for the years ended October 31, 2006, 2005 and 2004 was primarily attributable to SCOsource IP agreements....

The increase in other income, net, from the year ended October 31, 2004 to the year ended October 31, 2005, as well as the decrease from the year ended October 31, 2005 as compared to the year ended October 31, 2006 was primarily attributable to two items: 1) the collection of a note receivable from Vintela, Inc. (“Vintela”) as described in more detail in Note 10 to our financial statements, which note receivable was originally received in April 2003, but because we received the note receivable in exchange for the transfer of certain software to a related party and there was substantial doubt concerning the ability of Vintela to repay the note, no gain was recognized until the three months ended January 31, 2005 when we received payment; and 2) the sale of shares we held in Troll Tech AS (“Troll Tech”) as described in more detail in Note 4 to our financial statements. The Troll Tech shares had been written off in the year ended October 31, 2001, but because they were sold during the year ended October 31, 2005, we recorded income for the proceeds received. ...

Pursuant to the 1995 Asset Purchase Agreement and the Company’s acquisition of assets and operations of The Santa Cruz Operation, the Company acts as an administrative agent in the collection of royalty payments from a limited number of pre-existing Novell customers who continue to deploy SVRx technology. Under the agency agreement, the Company collects payments from such customers and receives 5% as an administrative fee and remits the remaining 95% to Novell on a routine basis. The Company records the 5% administrative fee as revenue in its consolidated statements of operations. The accompanying consolidated balance sheets as of October 31, 2006 and 2005 reflect amounts collected related to this agency agreement as of each balance sheet date, but not yet remitted to Novell of $2,978,000 and $2,815,000, respectively, as restricted cash and payable to Novell....

The Company’s SCOsource revenue to date has been primarily generated from agreements to utilize the Company’s UNIX source code as well as from intellectual property agreements....

The effect of accounting for stock-based awards under SFAS No. 123(R) for the year ended October 31, 2006 was to record $1,802,000 of stock-based compensation expense. ... As of October 31, 2006, the total compensation cost related to non-vested stock options not yet recognized was approximately $3,046,000 and the weighted-average period over which the total compensation cost related to non-vested stock options is expected to be realized is 2.65 years....

As part of the Engagement Agreement entered into on October 31, 2004, the Company started paying directly to Kevin McBride reimbursable expenses associated with the SCO Litigation, which primarily included document management, outsourced technical and litigation assistance, and travel expenses. During the years ended October 31, 2006 and 2005, the Company incurred expenses of approximately $562,000 and $323,000, respectively, to reimburse the expenses to Kevin McBride.